Encore Capital Group, Inc. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014. Encore purchases and collects defaulted consumer receivables and finances property-tax liens. Its portfolio purchasing and recovery business operates in the U.S., U.K., Colombia and Peru; tax-lien operations are primarily in the U.S.
Financial performance
| Metric | Q1 2014 | Q1 2013 |
|---|---|---|
| Total revenue | $253.7 million | $144.6 million |
| Operating income | $68.3 million | $38.7 million |
| Operating margin | 26.9% | 26.8% |
| Net income | $18.8 million | $19.4 million |
| Net income attributable to Encore shareholders | $23.2 million | $19.4 million |
| Basic / diluted EPS | $0.90 / $0.82 | $0.83 / $0.80 |
| Operating cash flow | $(2.6) million | $23.7 million |
| Cash and cash equivalents at period end | $196.4 million | $29.9 million |
Revenue from receivable portfolios was $237.6 million, up 68.9%; total revenue rose 75.5%. Gross collections increased 46.8% to $396.7 million. Management attributed growth chiefly to the AACC and Cabot acquisitions completed in 2013 and Cabot’s February 2014 acquisition of Marlin; Q1 2013 did not include those acquired businesses. The reported comparison is therefore not a like-for-like measure of organic growth.
Total operating expenses rose 75.2% to $185.5 million, broadly in line with revenue growth. General and administrative expense included $9.8 million of Marlin acquisition and integration costs. Interest expense increased to $38.0 million from $6.9 million, primarily reflecting acquisition-related debt and Cabot preferred-equity interest. The company reported $23.2 million attributable to Encore shareholders despite consolidated net income of $18.8 million, reflecting losses attributable to noncontrolling interests.
Financial position, debt and liquidity
At March 31, 2014, total assets were $3.43 billion, including $1.90 billion of receivable portfolios; debt was $2.61 billion, compared with $1.85 billion at year-end 2013. Debt included $1.59 billion of liabilities at the consolidated Cabot variable-interest entity; its creditors have no recourse to Encore. Cash was $196.4 million. Encore reported $469.6 million available under its revolving credit facility, excluding the $250 million accordion, and said it was in compliance with debt covenants.
Investing cash outflow was $353.0 million, mainly for Marlin and portfolio purchases; financing provided $420.9 million, principally through borrowings and debt issuance. Management stated it expected sufficient liquidity for at least the next 12 months, based on cash, expected operating cash flows, capital-market access and available facilities. Operating cash flow turned negative, partly due to decreases in operating liabilities and increased operating assets.
Changes, outlook and material matters
- Cabot acquired Marlin for approximately $274.1 million in February, expanding U.K. litigation-based collections. The purchase-price allocation was preliminary and expected to be finalized by Q4 2014.
- In March, Cabot issued £175 million of 6.5% senior secured notes due 2021, using proceeds in part to repay bridge financing. Encore also issued $161 million of 2.875% convertible notes due 2021.
- Encore amended its credit agreement in February; the amended facility has a February 2019 maturity, subject to shorter maturities for certain term-loan tranches.
- Management provided no specific earnings guidance and stated it generally does not make earnings projections. It expects U.S. receivable portfolio prices to remain elevated for some time amid constrained supply and strong demand. U.K. supply was expected to increase, while pricing was expected to remain elevated.
- Management noted seasonality: U.S. collections are generally strongest in Q1, while Cabot’s U.K. collections tend to be slower in Q1 and Q4. The company’s overall cost per dollar collected increased to 38.4% from 35.7%.
- Risks include high portfolio purchase prices and uncertain collection forecasts; acquisition integration and execution; consumer-protection regulation and litigation; substantial debt, variable interest rates and restrictive covenants; and possible dilution or cash requirements under convertible notes. The 2017 notes became convertible on demand in January; none were converted in the quarter.
- The company reported no material litigation reserves. It disclosed routine debt-collection litigation and regulatory matters, with outcomes or estimates sometimes not determinable. A gross $88.2 million unrecognized tax benefit related primarily to an uncertain AACC tax position; recognition would yield a stated net tax benefit of $18.7 million.
- After quarter-end, Propel completed a $134 million securitization of Texas tax liens at 1.44%, amended its tax-lien facility, and acquired a tax-lien portfolio for approximately $43 million. Encore completed its acquisition of Grove on April 1 and approved a $50 million share-repurchase program on April 24.
Important facts for investors to verify
- How much of revenue and collection growth reflects acquisitions versus underlying performance, and how Marlin performs against its preliminary purchase assumptions.
- Whether portfolio collection forecasts, estimated remaining collections and purchase-price assumptions remain supportable, particularly given elevated market prices.
- Debt service capacity and covenant headroom, including the effect of acquisition financing, variable-rate debt and convertible-note conversion or repurchase obligations.
- Whether negative operating cash flow is temporary and whether management’s stated 12-month liquidity expectation is supported by subsequent cash generation and facility availability.
- Developments in regulatory inquiries, consumer litigation and the AACC-related uncertain tax position.